What is a Preferential and Non-Preferential Creditor

August 12, 2020

As the impact of Covid-19 continues to sweep the nation, the number of businesses caught in the crossfire continues to grow. With an impending recession, many businesses will unfortunately face insolvency.

If your business is in a position where you feel it’s past the point of no return, there are a number of avenues you can explore to repay as much debt as possible. The first step you should take is to contact a licensed insolvency practitioner to assess your best option going forward.

Whether that’s making the decision to enter into Creditors’ Voluntary Liquidation, Members Voluntary Liquidation, Administration, Pre-Pack Administration or a Company Voluntary Arrangement (CVA), a licensed insolvency practitioner will guide you in the right direction.

In this article, we’re going to focus on a few of the key players in the formal liquidation process - the preferential and non-preferential creditor. We’ll explore both of their roles in the liquidation process as well as determining their differences to other creditors.

 

The Importance of the Insolvency Act (1986)

When a company is liquidated, insolvency practitioners must adhere to a legal hierarchy established by the Insolvency Act (1986) which determines which creditors receive their payout first.

The creditor hierarchy is as follows:

  1. Secured creditors with a fixed charge - Secured creditors include the likes of banks, mortgage providers, and asset finance companies.
  2. Preferential creditors - Preferential creditors include the businesses’ employees.
  3. Secured creditors with a floating charge and the ‘prescribed part’ - Assets subject to a floating charge often include stock, raw materials, work-in-progress, fixtures and fittings.
  4. Unsecured creditors - Includes the likes of unsecured credit card providers, bank loans, suppliers, landlords, and contractors.
  5. Shareholders

 

When a company submits a winding-up petition and enters into the formal liquidation process, the priority creditor groups must be repaid in full before moving on to the class of creditors that takes next priority. For example, secured creditors with a fixed charge must all be paid in full before preferential creditors are paid.

Creditors are paid once the assigned liquidator has liquidated the insolvent company’s assets.

In some instances, the money realised from liquidating the company’s assets will not be sufficient to repay every creditor. This can result in a proportion of creditors left with part or none of the money they are owed.

 

preferential creditor

What is a Preferential Creditor?

Generally speaking, when we talk about creditors, we refer to either an individual or a business that is owed money.

A preferential creditor is a creditor who is deemed to have preferential status over other creditors when it comes to receiving payment after the liquidation process. Essentially, preferential creditors are higher up the ‘repayment’ food chain than other creditors.

As we can see from the creditor rankings above, preferential creditors are the second set of creditors to receive their repayment. Secured creditors take highest priority.

 

What groups are considered Preferential Creditors?

Company Employees

The creditor hierarchy system suits the employees of the liquidated company as they are deemed preferential creditors. The liquidation process ensures that employees of a company are given a higher priority than most creditors.

This means that employees are entitled to arrears of wages up to £800, outstanding holiday pay and pension scheme contributions.

 

Tort Victims

If the liquidated company has been on the wrong side of the law, a tort allows the victim to claim the money they are owed or compensation through damages, injuries, or interference.

In the instance of a company entering insolvency, tort victims are classed as preferential creditors.

 

Financial Services Compensation Scheme (FSCS)

The Financial Services Compensation Scheme (FSCS) is a Government set-up deposit insurance and investors compensation scheme for customers of authorised financial services firms. The scheme compensates depositors if a firm is unable to pay the full amount back.

In 2014, the Banks and Buildings Societies Order was adapted, leading to a new type of preferential creditor being introduced in 2015 - the secondary preferential creditor.

The changes signified that depositors covered by the FSCS joined the list of preferential creditors in the formal insolvency process. Depositors are entitled to the amount they’re owed by the company as long as it’s below the scheme’s cap of £85,000.

When it comes to the time of payment, debtors using the FSCS scheme are paid after the regular preferential debts have been paid.

 

Is the HMRC a Preferential Creditor?

If you were asking this question pre-2002, the answer would be yes.

At present, the adaptations made to the Enterprise Act 2002 meant that HMRC’s preferential status was removed, making them an unsecured creditor.

Despite their demotion in creditor rankings, HMRC still has the authority to take the money they are owed from debtors straight out of their bank accounts if they meet certain criteria.

New legislation introduced in the Finance Act 2020 states that HMRC will regain its status as a preferential creditor for insolvencies that occur on or after the 6th April 2020.

As of the 1st December 2020, HMRC will leapfrog floating charge holders as a secondary preferential creditor for certain debts such as: VAT, PAYE, NICs and Construction Industry Scheme deductions.

Despite climbing the creditor ladder, HMRC will be the lowest priority category of preferential creditors when it comes to distributing the insolvent companies’ funds.

In relation to corporation tax or any subsequent tax owed directly to the company, HMRC will still be regarded as an unsecured creditor.

A cap on the age of preferential status tax debts is yet to be established and HMRC have stated that the reform will ensure that ‘’when a business becomes insolvent, more of the taxes paid in good faith by that business’ employees and customers will fund public services, rather than these being distributed to other creditors such as financial institutions’’.

 

What groups are considered Non-Preferential Creditors?

Unsecured creditors include a company’s standard trade creditors, suppliers, customers, contractors, and HMRC (for now).

If there is any money left to squeeze out of an insolvent company’s assets, the unsecured creditors are paid after the preferential debts have been settled.

 

Get in touch with a Licensed Insolvency Practitioner

Insolvency is a tricky area to navigate and it’s important to have a professional to help you make the best decisions for you, employees of the business, your creditors, and to keep you on the right side of the law.

If your company is going through a difficult period financially, there’s no better way to put your mind at ease than having a chat with a licensed insolvency practitioner.

At 180 Advisory Solutions, we have an experienced team of insolvency professionals on hand to guide you through the liquidation process. We’ll assess your company’s financial position and confirm the company’s preferential creditors in cases where more than one charge-holder is in place.

Please don’t hesitate to contact us as soon as possible.

Professional Indemnity Insurance – our professional indemnity insurer is Mapledown Royal & Sun Alliance plc , Mapledown Underwriting LLP, The St Botolph Building 138 Houndsditch London EC3A 7AG and policy number is RTT262119/11273. The territorial coverage is worldwide (excluding professional business carried out from an office in the United States of America or Canada) and excludes any action for a claim brought in any court in the United States of America or Canada.


GLASGOW LIVING WAGE EMPLOYERBarry John Stewart and George Dylan Lafferty are authorised to act as insolvency practioners in Glasgowa> and the UK by the Institute of Chartered Accountants of Scotland. Company Registration Number SC 477598 | VAT Registration Number 192 5146 03 | Data Protection Registration A1056203 | FCA Registration Number 766693 | Registered office: 2nd Floor Suite 148, Central Chambers, 11 Bothwell Street, Glasgow G2 6LY.